Why Is the Dollar Losing Value?

Feb. 27, 2008 — -- Dreams of vacationing in Europe just got a lot more expensive, with the dollar falling to new lows against the euro and the British pound Wednesday after a series of negative economic reports from the United States. At one point during trading, it cost just more than $1.50 to buy one euro and nearly $2 to buy a one pound. That means an American in Paris will spend a lot more to buy a flaky croissant.

So why is the dollar plunging, and what impact does that plunge have on U.S. and world markets? Here's a look at some of the reasons for the dollar's fall, and the consequences.

There are several reasons. First, there's the difference between the interest rate in the United States — currently 3 percent — and interest rates maintained by central banks around the world.

How Is the Economy Treating You? Tell ABC News

While the United States has dropped its rate, other banks have not followed. The spread between the interest rate at the European Central Bank (home of the euro) and the Federal Reserve (home of the dollar) is larger and that has weakened the value of the dollar against the euro. Put another way, you would get a better interest rate return holding a euro than a dollar.

Second, central banks around the world have been diversifying their holdings away from dollars to euros, British pounds and so on. That means there are more dollars out there in currency markets available to purchase. More dollars floating around means diminished value.

Look at the record-high price of oil. Even if the same amount of oil is being pumped out of the ground, since it is traded in dollars and the dollar has weakened, the price of oil has increased to make up for the lost value of the dollar, creating a sort of vicious cycle.

Oil-producing countries don't want to keep all the dollars they are getting for their oil, since it's worth less, so they are diversifying and converting their dollars into euros or other currencies. That pushes more dollars back out into currency markets, which in turn pushes down the dollar's value.

One analyst told ABC News that Russia used to have 90 percent of its financial reserves in dollars. It now has 45 percent in dollars, 45 percent in euros and 10 percent in British pounds.